Dropdowns:

Since the firm is currently using () % debt financing, it (is, is not) at its optimal capital structure and (Should not change the capitol structure, should substitute some debt for equity, should substitute some equity for debt.)

C. As a firm initially substitutes debt for equity financing, what happens to the cost of capital?

The cost of capital initially (decreases, increases, does not change)

D. If a firm uses too much debt financing, why does the cost of capital rise?

If a firm uses too much debt financing, the firm becomes (more, less) financially leveraged and riskier. This causes the interest rate to (rise, fall) and the cost of equity to (increase, decrease) These changes in the cost of debt and equity cause the cost of capital to (increase, decrease)

Problem 21-05 a. Given the following, determine the firm's optimal capital structure: c. What two reasons explain why debt is cheaper than equity? Debt is cheaper than equity because interest expense -Select- Debt/Assets 0% 10 20 30 40 50 60 % After-Tax Cost of Debt 6% 6 7 7 9 10 12 Cost of Equity 11% Round your answers for capital structure to the nearest whole number and for the cost of capital to one decimal place. The optimal capital structure: % equity with a cost of capital of % debt and b. If the firm were using 40 percent debt and 60 percent equity, what would that tell you about the firm's use of financial leverage? Round your answer for the cost of capital to one decimal place. If the firm uses 40% debt financing, it would be using -Select- financial leverage. At that combination the cost of capital is -Select- %. The firm could lower the cost of capital by substituting 11 11 12 14 15 16 % . In addition, equity investors bear -Select- risk. d. If the firm were using 20 percent debt and 80 percent equity and earned a return of 9.8 percent on an investment, would this mean that stockholders would receive less than their required return of 11.0 percent? If the firm earns 9.8% on an investment, the stockholders will earn -Select-than their required 11.0%. What return would stockholders receive? Round your answer to one decimal place